Phil Milburn

Weighing the debits and credits

Phil Milburn

Amid all the debate around the fallout from COVID-19, we have been surprised by how little we have seen about what the massive stimulus efforts actually mean against the potential economic destruction caused by the virus. Adding and weighing the debits and credits, if you like.

As we head through the second quarter of 2020, we are likely facing the biggest year-on-year slowdown on record, with estimates ranging from 20% to 30% of global GDP lost. To put some figures on this, if we take global GDP from 2019 to be $87 trillion, we are talking about value destruction in a single quarter of $6.5 trillion (based on a 30% level).

These are obviously frightening numbers but, equally unprecedented, is the fact that combined fiscal and monetary support is already materially higher. As the table below shows, the current estimate of the global monetary response is a conservative $5 trillion (technically, the capacity here is infinite), with a similarly conservative $5 trillion estimate of fiscal support. IMF calculations actually put combined fiscal stimulus packages in the region of $8 trillion.

The monetary policy is designed to buy time for companies and economies while the fiscal side is targeting individuals and consumption; it is important to understand that these are not measures expected to stimulate growth.

COVID monetary and fiscal responses by country

We all know the macroeconomic data will be dire in the short term, and while this monetary and fiscal support is immense, the ultimate impact depends on the speed and efficacy of the transmission mechanisms. How successful markets deem these to be, as well as the emerging exit strategies from lockdown, will be key for the short-to-medium term direction of risk assets.

As bond investors, we are less interested in earnings growth over the next few quarters than the ultimate preservation of the financial system and here, we feel recent Federal Reserve activity has changed the game, very much in favour of fixed income.

On 7 April, the Fed announced the details of its $850 billion credit asset purchase plan, as well as extending existing policies to cover ‘fallen angels’, municipal bonds and high yield ETFs. Again, it is worth adding up the numbers here: the overall US credit market, including municipals, is worth around $13 trillion, and things were broadly balanced last year, with a supply of $1.8 trillion and demand (factoring in maturities and coupon flow) of around the same.

With $100 billion of redemptions from credit mutual funds sparking panic in March, this move from the Fed acknowledges that lending, rather than ownership, is key to preserving the system. Balance sheets are integral to long-term systemic recovery, and lending facilities and retained capital can tide us through a few quarters of earnings losses a premise that obviously favours bonds.

The Fed’s $850 billion commitment makes a huge difference if you consider the make-up of the $13 trillion market, with just 19% held by mutual funds and more than 60% by longer-term owners such as life and pension funds. This $850 billion represents a third of the entire US credit mutual fund market, and the Fed has trillions in reserve if need be, so we can assume short and longer-term support for corporate debt. As the old saying goes, we have no desire to fight the Fed.

Make-up of US credit market

Make-up of US credit market

Source: SIFMA (Securities Industry and Financial Markets Association), March 2020

Given this backdrop, we have increased credit exposure in our Strategic Bond portfolios from 60% at the start of the year to 85%. This includes 55% in investment grade, up from 45% in February, and our positions are mainly large, listed and skewed to the US, and almost all of these bonds would qualify for Fed purchases.

Our high yield exposure has moved up to 30% (from 15% in January and relative to the 40% ceiling in our Strategic Bond funds), and, again, we highlight new support for this end of the market from the Fed and  countries like Germany, which have pledged “support for all companies”.

We also maintain a 15% allocation to US Treasury Inflation Protected Securities: these have rallied around 10% since they were added to the Fed’s shopping basket but remain cheap, providing both a decent amount of the funds’ overall duration and inflation protection. Central banks have said they will be tolerant of any inflation overshoots given how much stimulus is being pumped into markets, so the latter could prove a useful hedge.

Overall, we remain positioned for recovery but are not predicting a V-shaped bounceback, rather a scenario where the system survives and, within that, the importance of lending to companies remains. We are not calling the bottom of the market for credit but do have cash available to take advantage of opportunities where they arise. In doing so, we continue to draw on lessons learned from sell-offs during the 2008 crisis, particularly in areas like high yield, as we look to avoid defaults and buy stressed rather than distressed assets.

For a comprehensive list of common financial words and terms, see our glossary here.


Key Risks

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. Investment in Funds managed by the Global Fixed Income team involves foreign currencies and may be subject to fluctuations in value due to movements in exchange rates. The value of fixed income securities will fall if the issuer is unable to repay its debt or has its credit rating reduced. Generally, the higher the perceived credit risk of the issuer, the higher the rate of interest. Bond markets may be subject to reduced liquidity. The Funds may invest in emerging markets/soft currencies and in financial derivative instruments, both of which may have the effect of increasing volatility.


The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing.

Thursday, April 23, 2020, 10:50 AM